Leveraged Populists

The recent offering of Facebook stock was the biggest news since a man landed
on the Moon. The story was everywhere. Someone said the company is worth $100
billion and that was repeated one-hundred billion times. It is the saturation
of noise, more than the supposed price, that should warn investors. This too,
shall pass.

Technology stocks such as Facebook are a means for investors to put their
money where their hearts lie. At the turn of the millennium the world lost
its mind over technology stocks. This eerie atmosphere is too well known to
require description. A merger of the time will substitute.

The America Online-Time Warner combination proved the thesis of "convergence." Stock
phrases and Star Wars' linguistics had inflated AOL stock. ("To you, peering
through your spectroscope, mapping the mazes of electromagnetism in its path,
the web appears as a global efflorescence....the physical phase of the telescom,
the radiant chrysalis from which will spring a new global economy." - George
Gilder, widely hailed technology expert)

Page one of the New York Times Convergence Edition in January 2000
frames the all-telling photograph, captioned: "Steven M. Case, chief executive
of America Online, with tie, and Gerald M. Levin, chief executive of Time
Warner, without tie, announcing the merger."

What beckons of course, is the haberdashery insight. "Left" and "right" would
have fully explained who dressed down. So why the phrase? (To youngsters:
Dressing down was still relatively new on January 5, 2000, so notable.)

It was an underscore. Here we had the Old Economy, and older man, agreeing
to be bought out by the New Economy. Gerald M. Levin surrendered to the young
man's conquest of the Old Media. Levin had embraced the New Era, albeit, disrobed,
demoted and humiliated before the public like Chuck Connors in Branded.
Steven M. Case, an internet idol, wore his tie, a sign of respect for the
old, shrunken media mogul who had seen the future in the nick of time. An
industry analogy might be a silent movie studio that refused to make talkies
in 1930.

In 1927, a third-rate movie studio, Warner Brothers, released the first talking
picture: The Jazz Singer. Practically breaking the bank with a $3 million
publicity campaign, the studio's technological escapade swept the nation.
We might compare the mass hysteria to the Facebook or AOL-Time Warner silliness.
Every studio was soon borrowing and then borrowing some more to catch up with
the People's latest need. That was a period, like our own, when cravings
equaled needs. A substantial proportion of the lower classes in Muncie, Indiana
(Middletown) mortgaged their houses that they had owned to buy a car.
Twenty one of twenty-six families that bought cars (in the lower strata) did
not own a bathtub.

That was also a time when borrowing was easy. Lending to a booming, fashionable,
and technologically cutting-edge business was fashionable in itself. By that
time, movies were the fifth largest industry in the United States, where 90%
of the world's films were made - indicating the tendency of American minds
to admire visual (rather than verbal) expression and drift towards fantasy.

After 1929, financing was hard to come by and the highly leveraged studios
needed constant infusions of cash. Most went broke. Those who bought and held
Warner Brothers Pictures at its $67 peak could sell it for $1 in 1933. Unambiguous needs during
the 1920s turned to superfluous cravings a few years later. In The Crash
and Its Aftermath, Barrie Wigmore wrote that movie sales dropped [in 1933] "to
$546 million from $831 million in 1931....Somehow a myth has developed that
Depression crowds anxious for escape sustained the movie business. This is
not even remotely true."

William Fox and Sam Warner retained control, but investors went broke. How
they accomplished this feat might be studied by Facebook executives today
presuming the Warners of 2012 can identify their revenues.

AOL bought Time-Warner with 45% of its stock: no cash. This gave AOL 55% ownership
- and control - of AOL-Time Warner. The stock offered was worth $165 billion.
In return, AOL now owned a company that had produced $6 billion of cash the
year before. AOL's cash flow was about one-quarter that amount. Time Warner
stock was trading at about 20 times cash flow, fairly high by historical market
measurements, but a pittance compared to AOL's price: cash flow ratio of 110:1.

Levin's dressed-down marriage with AOL was quite a miscalculation. Even so,
it is worth remembering that the company he headed is an example of the past
half-century's leveraged finance, an aggregation of overpriced miscalculations.
For the most part, finance has profited: not the companies, not the shareholders,
not the customers, nor the employees.

A source of the late 1960s "garbage market" was identified by John Brooks
in the Go-Go Years: "Accountants came to think legalistically rather
then conscientiously." This prompted offerings that, today, could make for
a raucous feast on the Daily Show. Brooks writes of stocks for every
fad: For nursing home fans, there was United Convalescent Homes. The budding
fanciers of a greener world could buy Responsive Environments. For those who
predicted a boom in spare time, International Leisure filled the bill.

The headline merger of the millennium gained traction during this rumpus.
A funeral-parlor chain bought D.C. Comics and Ashley Famous Talent Agency
in 1967; the morticians then bought Warner-Seven Arts in 1969; it renamed
itself Warner Communications in 1972; Warner Communications bought cable operator
American Television & Communications in 1978; Warner Communications and
Time Inc. merged in 1989 to form Time Warner; Time Warner acquired Houston
Industries in 1995; Time Warner acquired Turner Broadcasting Systems in 1996,
this included Ted Turner's acquisitions and product launches - the Atlanta
Hawks (1977), CNN (1982), the MGM library of movies and television shows (1986),
Cartoon Network (1992), Castle Rock and New Line Cinema (1993), Turner Classic
Movies (1994); Time Warner acquired Times Mirror magazines in 2000; and America
On-Line bought Time Warner for $165 billion in 2000 - without one penny changing
hands. As noted, payment to Time Warner shareholders was in America On-Line
stock.

The day after Facebook monopolized the news, a proposed merger went relatively
ignored. Initially priced at $88 billion, Glencore and Xstrata continue to
negotiate with each other. The combination would produce, refine, transport,
and sell most of the world's commodities that are harvested in most of the
world's countries and then sold in most of the world's markets.

As for AOL-Time Warner, it did not take long for Gerald Levin to be shown
the door. Time Warner spun off what little was left of AOL in 2009. In January
2000, Steve Case had taken his winnings and bought pineapple plantations in
Hawaii.

Sheehan serves as an advisor to investment firms and endowments. He is the
former Director of Asset Allocation Services at John Hancock Financial Services
where he set investment policy and asset allocation for institutional pension
plans. For more than a decade, Sheehan wrote the monthly "Market Outlook" and
quarterly "Market Review" for John Hancock clients.

Sheehan earned an MBA from Columbia Business School and a BS from the U.S.
Naval Academy. He is a Chartered Financial Analyst.